Prachi Juneja
This article is reprinted from ManagementStudy Guide.com, an educational portal launched in 2008 with the object of providing students and corporate workforces with access to rich, easy- to-understand, frequently updated instruction on management-related topics.
The United States is economically the most powerful nation in the world today. This is what makes the study of central banking in the United States all the more interesting. Almost all other countries in the world adopted central banking without any major hassles. However, in the United States, a lot of conundrum took place before central banking could be established.
The Founding Fathers of America were opposed to the idea of a central bank and they had explicitly mentioned this opposition when Thomas Jefferson called central banks more dangerous than “standing armies.” The idea of central banking was therefore considered to be unconstitutional and the general population had to be convinced to adopt this concept. In this article, we will trace the history of the three central banks that were set up in the United States.
1791 to 1811: The First Bank of United States
The First Bank of United States was proposed in the very first meeting of the first Congress. Alexander Hamilton, one of the forefathers, believed that a central bank would be indispensable to facilitate the swift transfer of money across states as well as to provide credit to the state governments. However, the idea faced multiple obstacles from other leaders such as Jefferson. Despite Jefferson’s vehement opposition, the First Bank of United States came into existence in 1791, just 15 years after America gained independence.
Jefferson’s opposition was not the only obstacle faced by this bank. The conditions were not rife for banking at that time. There were over 50 different types of French, Spanish, Portuguese and American currencies in circulation at that time. Also, the bank's charter was valid only for a limited period of 20 years, after which it was supposed to be renewed. The first bank kept expanding its operations during the tenure. Even one year prior to the expiry of the charter, additional branches were opened along the East Coast of the United States.
However, President Madison did not renew the charter of this bank in 1811 amidst rising concerns of inflation and allowed central banking in the United States to come to a sudden end for a short while. Many believe this created monetary instability which lasted for many years following 1811.
1816 to 1832: The Second Bank of United States
For the five years after the collapse of the First Bank of United States, monetary instability ran rampant across the United States. The impact was large enough for the Congress to consider the creation of another central bank called the Second Bank of United States. This was the successor to the first bank and had virtually the same rights and privileges. The second bank also had monopoly rights over creation of paper money and regulating its value thereof.
However, the second bank faced much larger opposition as compared to the first bank. The seventh president of the United States, Andrew Jackson, vehemently and publicly opposed the central bank, calling it the work of “monied interests” to ensure their continued domination over the average American. Jackson portrayed the second bank as an extremely corrupt institution that needed to be uprooted from American soil if economic independence were to be maintained. He led a campaign against the bank and finally the second bank also collapsed in 1832, even before it could complete the 20-year tenure that had been granted to it by the charter.
1913 to Today: The Federal Reserve
The United States did not have a central bank from the period between 1832 and 1913. Surprisingly, the United States’ trade and commerce were functioning perfectly fine until the 1900s. In the early 1900s, the United States faced a series of financial panics and crises. Most notable among these crises was the crisis of 1907. Many banks ended up bankrupt during this period and people ended up losing their life’s savings. As a result, there was public clamor directing the government to bring in some regulation in the banking practice.
After many discussions and negotiations, the Federal Reserve Act was finally passed in 1913 and the United States once again had a central bank. This time, the bank has stayed on for many years. One of the reasons behind this is that the charter does not have a limited validity and does not require multiple approvals from the Congress every few years.
Creating the Federal Reserve was a challenge for American senators. They had to create a system to regulate the practices of fraudulent banking. However, they also had to ensure that vested monied interests did not get an upper hand during the process. To ensure this, the Federal Reserve act created a quasi-government body. This meant that although private bankers were part of the Federal Reserve in order to provide industry expertise, the ultimate control of the Fed’s action lay within government hands. This convinced the general population that there were no sinister motives behind the creation of the Federal Reserve.
The Federal Reserve Act also ensured that the government does not have excessive control over the Fed. It kept the monetary policy out of the control of the president. Also, the Fed does not require congressional approvals in the normal course of its business.
Thus, through the Federal Reserve Act, the American population has discovered the ideal mix of regulated central banking as well as avoidance of monetary meltdowns. Central banking which had earlier been despised in America now found a permanent place in its economic system.
Prachi Juneja is a senior leader and vice president of advanced analytic solutions at Dun & Bradstreet and a contributing writer to ManagementStudyGuide.com. Reprinted by permission.